Credit Default Swaps and the EU Short Selling Regulation: A Critical Analysis

The article provides a detailed analysis of the EU Short Selling Regulation (236/2012), which imposes significant changes to the European credit default swap (CDS) market. The Regulation consists of two principal elements: mandatory disclosures and short selling restrictions. The disclosure regime is found to be broadly reasonable, but it includes several inconsistencies, which exacerbate regulatory fragmentation and reduce the ability of regulators to identify abuses in the CDS market. The restrictions on uncovered sovereign CDS positions reflect an insurance-based view of credit default swaps; this is modestly supported by the empirical literature, but it is not developed consistently in the Regulation. The definition of hedging creates uncertainty, and the exclusion of corporate CDSs provides opportunities for regulatory arbitrage. There is an opting-out regime, which may go unused, because the conditions for invoking it are tight and possibly illogical. The Regulation also creates new powers of intervention in exceptional situation, potentially provoking turf battles between national regulators and the European Securities and Markets Authority (ESMA).